What is an IRA?

QUICK LINKS

• How do IRAs work?
• Should I have an IRA?
• Starting an IRA account

How do IRAs (individual retirement accounts) work?

To ensure that most people have enough money to see them through retirement, the  federal government has created a few different ways to encourage saving, primarily by offering tax breaks. An IRA, which is designed for long-term retirement saving, is one of those ways.

Anyone can open an IRA account through a broker or an online brokerage account. Then you can purchase a variety of investments and financial instruments inside of your IRA account, and any earnings grow without being subject to current income taxes. There are a few rules, like how much you can contribute each year and when you can start accessing the funds, that we’ll explain below.

Why invest in IRAs for retirement?

We all need to save in order to have a healthy retirement, so we might as well do it in an account that provides tax advantages. It doesn’t take much effort to begin building a savings vehicle that can help you work towards your retirement goals.

Why are IRAs better for taxes?

With traditional IRAs, you are allowed to make pretax contributions, which reduce your taxable income for the year, assuming you meet the income limitation requirement. But you will pay taxes when you withdraw the funds in retirement. You end up paying taxes either way, so what’s the difference? Well, most people are in a lower tax bracket after they retire than they were during their working years. Among other benefits, that means your retirement income will be taxed at a lower rate. In addition, the money that would have been used to pay taxes has a chance to grow in your account over the years, so there’s considerably more money in the account when you reach retirement age and start withdrawals. Roth IRAs also grow tax free, and they can be more flexible in one respect: you can withdraw contributions (but not earnings) at any time without taxes or penalties. However, Roth IRAs have income limitations that restrict who can contribute, so they aren’t universally more flexible in every situation.

When should you start an IRA?

When it comes to saving for retirement, the earlier you start, the better. Since any earnings in an IRA grow tax-free (Roth) or tax-deferred (traditional), the longer they can sit untouched, the more they will compound and grow. Some people even start IRAs for their children while they are still in school to give them a head start. But most people truly begin saving during their prime working years. As soon as you have extra savings that you feel comfortable putting away, it’s time to think about setting up an IRA.

Can IRAs lose money?

Yes. IRAs are tax-advantaged holding accounts for investments, and with investments, there is always a risk. If your portfolio declines in value, your IRA will lose money. While diversification does not guarantee any results, a well-diversified IRA is a prudent way to save for retirement. If you have questions or would like help building a well-balanced IRA for your specific needs, you should speak with a financial services professional.

How many IRAs can you have?

Technically, there’s no limit to the number of IRAs you can have, but the contribution limits apply to all of your accounts combined. For the 2025 tax year, the yearly contribution limits are $7,000 if you are under age 50, and $8,000 if you are age 50 or over. This limit is subject to change. There are a few reasons some people may want to have multiple IRA accounts, but generally one or two is plenty.

How is an IRA different from a 401(k)?

401(k) accounts have similar tax advantages, but they are sponsored by an employer. Many employers match some of the contributions you put in your 401(k), giving you another way to increase your retirement savings. For the 2025 tax year, contribution limits are higher: $23,500 if you are under age 50, plus an additional $7,500 in catch-up contributions for those 50 or older. Beginning in 2025, if the plan allows, individuals aged 60 through 63 can make a catch-up contribution of up to $11,250. If a 401(k) is an option at work, you should take advantage of it.

Types of IRAs.

While all IRAs have the same goal—providing tax breaks to encourage people to save for retirement—there are key differences in how they help you get there. Understanding how taxes apply and investments grow can make all the difference when it comes time to reap the benefits in your golden years.

Traditional IRA:

Contributions into a traditional IRA are federally tax-deductible (provided you meet applicable requirements)  and may also be deductible for state tax purposes, depending on your state of residence. In addition, all growth within the account is not subject to current income taxes. That can be huge. For instance, contributing $6,000 a year over a few decades (depending on your age and assumed rate of return) can lead to a retirement balance exceeding $1 million, which would then be taxed as distributions are made. You should avoid accessing this money until you are 59½. There are ways to get some of the money out sooner, but you’ll likely have to pay a 10% IRS penalty tax. When you withdraw the funds in retirement, they are taxed as ordinary income.

Roth IRA:

Roth IRAs work almost backward compared with traditional IRAs. Your contributions up front are funded with earned income on which you’ve already paid taxes. When you start withdrawing your funds, those withdrawals are tax free. Roth IRAs also allow you to pull out contributions at any time without taxes or penalties, but accessing earnings may trigger taxes and penalties unless you are over age 59½ and have held the account for at least five years.

Although Roth IRAs don’t offer the same immediate tax deduction as a traditional IRA, their tax-free withdrawals in retirement can be advantageous. Both traditional and Roth IRAs do require that you have earned income at least equal to the amount you contribute, and Roth IRAs have income limits that can prevent higher earners from making direct contributions. A financial services professional can help you decide whether a traditional or a Roth IRA might be best for you

SEP and SIMPLE IRAs:

SEP (Simplified Employee Pension Plan) and SIMPLE (Savings Incentive Match Plan for Employees) IRAs are products that are employer sponsored, and more like 401(k)s. They are generally used by smaller, family-run businesses to help their employees save for retirement.

Comparing IRAs:

When it comes down to it, the main choice is between a traditional or a Roth IRA, and it really depends on when you want to pay taxes: now or later. Here’s a simple comparison between the two:

Starting an IRA (individual retirement account).

When you’re ready, starting an IRA for yourself or a dependent is a pretty simple process. Just follow the steps outlined below.

Opening an IRA.

You can open an IRA at a lot of places, like banks, brokerages that offer hands-on management, or an online investment account. Each comes with pros and cons, and fees will change depending on how much assistance you’re getting. Once you know where you’re going to set up your account, you’ll simply have to choose the type.

Contributing to an IRA.

Once set up, you can start funding your account immediately. Remember, there is a yearly contribution limit. It’s generally advised that you put in the maximum allowed amount every year if you can afford to do so. That will ensure maximum growth of your account over time.

When can you withdraw from an IRA?

To avoid tax penalties, you’ll need to wait until age 59½ before withdrawing funds from an IRA. (In certain specific instances, you may be able to make a hardship withdrawal without paying the 10% tax penalty. But you will owe ordinary taxes on that money.) Remember, this savings account is for your retirement, so it’s best to wait. With a traditional IRA, you will have to begin required minimum distributions (RMDs) by age 73,* so you have some wiggle room to keep your investments growing should you work longer, or should you have other savings to fund your early retirement.

Choosing your investments.

When you contribute funds to an IRA, you’ll need to select investments. If you’d like help setting up or funding an IRA, or would like professional guidance on where to invest your hard-earned savings, a financial services professional at NYLIFE Securities can help.